State BPA Fundamental Accounting Practice Exam

Which of the following is true about liabilities?

1. Liabilities are increased by debit

2. Liabilities are reduced by credit

3. Liabilities are increased by credit

4. Liabilities can be both credited and debited

The correct answer is: Liabilities are increased by credit

Liabilities represent obligations that a business owes to external parties, such as loans, accounts payable, and mortgages. In accounting, the rules of double-entry bookkeeping dictate how accounts are affected by transactions. When a company incurs a new liability, for instance, borrowing money, this action increases the total amount of liabilities on the balance sheet. In terms of journal entries, an increase in liabilities is recorded with a credit. Conversely, when a liability is settled or paid down, such as repaying a loan, this action would reduce the liability. A decrease in liabilities is recorded with a debit. Therefore, the statement that liabilities are increased by credit accurately reflects this fundamental accounting principle. Understanding the impact of each transaction on the financial statements is crucial, and recognizing that credit entries increase liabilities helps establish a solid foundation for interpreting a business's financial position.